By Nick Timiraos 

Federal Reserve officials finish their two-day meeting Wednesday recognizing they may need to cut interest rates should the economic outlook darken. The question is whether that moment has arrived or if they need more information before deciding.

Recent economic data paint a mixed picture, with consumer spending still solid, but with manufacturing, inflation and global growth having slowed even before the recent escalation in trade tensions.

Policy makers are considering whether their short-term benchmark rate, which has been in a range of 2.25% to 2.5% this year, is curbing economic growth more than they expected, especially if uncertainty over U.S. trade policy chills business investment and weakens corporate profits.

Broadly speaking, the case for cutting rates is stronger than when officials met April 30-May 1. Back then, they were more optimistic on the economy and their make-no-moves policy stance, largely because a U.S.-China trade deal appeared in sight.

Since then, President Trump increased tariffs on China as negotiations stalled and threatened to impose tariffs on Mexico. He later suspended the threat, subject to a review of Mexico's efforts to curb migration, sowing new uncertainty about trade policy.

The episodes rattled business confidence and led bond investors to begin predicting Fed rate cuts beginning at its July 30-31 meeting. The Mexico tariff threat also illustrated the difficulty Fed officials face in forecasting economic outcomes given Mr. Trump's mercurial trade policies.

On Tuesday, Mr. Trump kept up pressure on the Fed to cut rates even though Chairman Jerome Powell has said the central bank doesn't take political considerations into account.

"Let's see what he does," Mr. Trump said in response to a question about whether the White House would seek to replace Mr. Powell as Fed chairman. Mr. Powell has said he won't leave his position before his current term expires in 2022.

The choices at this meeting are between cutting rates now if officials see the economic outlook worsening or holding off and cutting next month if the picture grows darker. There are strong arguments on both sides.

Some Fed officials have said they would prefer to wait until the July 30-31 meeting to see if data and political events provide a stronger signal about whether the economy needs more stimulus. They have signaled reluctance to respond to trade uncertainty before next week's G-20 summit in Japan, where the U.S. and China could put trade talks back on track.

Mr. Trump on Tuesday delivered a reminder of the fluid trade situation when he announced plans for a meeting next week with Chinese President Xi Jinping at the Osaka summit. The two leaders spoke by phone Tuesday.

"I want to take a little bit more time...because some of these recent events could be reversed," said Dallas Fed President Robert Kaplan in a June 4 interview, before Mr. Trump decided to suspend the tariffs on Mexico.

On the other hand, officials are mindful of research finding that when their policy rate is historically low, leaving less room to cut it in a downturn, they should move more quickly to respond to any economic shakiness.

If officials think the risks of more trade disputes are unlikely to diminish or that the economic data are unlikely to improve before their July meeting, they could argue there is less benefit and more risk to waiting to cut rates.

Low inflation readings coupled with rising risks to growth from trade frictions may warrant lower rates, said St. Louis Fed President James Bullard in comments to reporters June 3.

"The previous narrative was that deals were just around the corner...and now it looks like trade deals are not around the corner," he said. "It's the global trade regime uncertainty factor that is adding impetus to the case for a rate cut," he said.

Fed officials are also wrestling with questions regarding how their decision last year to raise their benchmark rate above the inflation rate rippled through the economy.

Inflation slowed this year, rather than holding at the Fed's 2% target as officials expected late last year. Excluding volatile food and energy categories, prices rose 1.6% in April from a year earlier, according to the Fed's preferred gauge. Global commodity price declines indicate weaker growth abroad could continue to hold down prices.

Fed officials pay especially close attention to businesses' and households' expectations of future inflation because they believe these expectations strongly influence actual inflation. The University of Michigan's June consumer survey showed expectations of annual inflation over the next five to 10 years fell to 2.2%, an all-time low for the 40-year series.

While job growth this year has slowed to levels in line with what Fed officials have expected, some data hint at more potential weakness if economic activity decelerates further. Year-over-year growth in total weekly hours worked for nonsupervisory workers slowed to 1.1% in May, from 2.8% in January, and manufacturing overtime hours are 6.7% below the year-earlier level, according to Deutsche Bank.

Other major central banks are lowering rates or considering cuts to combat weaker global growth. On Tuesday, European Central Bank President Mario Draghi signaled the bank could roll out new stimulus next month, and several Asian central banks have eased policy this year. Australia cut its policy rate this month for the first time in three years.

Fed officials could cite signs of cooling global momentum if they cut rates this week.

If they hold off, markets will parse Powell's comments in his postmeeting press conference Wednesday to see if they bolster or push back against market expectations of a July rate cut. "A lot will depend on the tone of the announcement and the tone of the press conference," said Donald Kohn, a former Fed vice chairman.

At a minimum, officials appear likely to replace language in their policy statement that since January has said they would be patient in making further rate changes. The language signaled a stance with no bias toward moving rates up or down. They are also likely to acknowledge that risks to economic growth have risen.

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

June 18, 2019 19:27 ET (23:27 GMT)

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